On selection of Income Tax assessee's Foreign Associated Enterprise as "Tested Party" in Transfer Pricing analysis: What Madras High Court ruled

The Madras High Court recently clarified that in determining transfer pricing, to ascertain the net profit margin realised by an enterprise from international transactions, the tested party selected can also be a foreign associated enterprise of the income tax assessee, by applying the least complex theory (M/s Virtusa Consulting Services Private Limited v DCIT, Chennai). .The Bench of Justices TS Sivagnanam and RN Manjula noted that in the case of Yamaha Motor India Limited vs. ACIT, the tax tribunal had observed that the words "Enterprise" and "Associated Enterprise" have been used interchangeably in the Income Tax Act. .From the definition of "Enterprise" given in Section 92F(iii) and "Associated Enterprise" in Section 92A of the Act, it is clear that the statute does not indicate that "Enterprise" should necessarily mean the assessee and that the "Associated Enterprise" should mean the other party, the tribunal had ruled in the Yamaha Motor case. .Further in Ranbaxy Laboratories Limited v. ACIT, the Court noted that the Delhi Bench of the Tribunal had culled out that,"... the tested party normally should be the least complex party to the controlled transaction and that there is no bar for selection of tested party either local or foreign party and neither the Act nor the guidelines on transfer pricing provides so and the selection of tested party is to further the object of comparability analysis by making it less complex and requiring fewer adjustment.".The High Court made the observations in an appeal preferred by a Multinational company, M/s.Virtusa Consulting Services Private Limited against an ITAT ruling. The ITAT had ruled that the tested party for carrying out transfer pricing analysis should be the assessee and not its foreign associated enterprise. .The Tribunal's ruling was largely guided by the decision of the Mumbai Tribunal in Aurionpro Solutions Limited, the High Court was told, wherein the tribunal had ruled that the tested party for the purpose of determination of Arm's Length Price (ALP) is always the assessee and not the Associated Enterprise. .The High Court, however, agreed with the assessee/appellant's contention that on facts, the decision in Aurionpro Solutions Limited vs. Additional Commissioner of Income Tax could not have been applied to the case at hand. .In this regard, the High Court also disagreed with the ITAT's finding that the assessee had failed to establish the functional risks assumed by its foreign Associated Enterprises. .The determination of the functional risks of an entity assumes relevance when it comes to determining the least complex entity. Pertinently, one method of carrying out transfer pricing is to take the least complex entity as the tested party. .The assessee, in this case, asserted that its foreign Associated Enterprise was the least complex entity and, therefore, should be selected as the tested party instead of the assessee located in India. .They had taken a different stance in their Transfer Pricing documentation initially. However, they chose their foreign associate enterprise as the tested entity before the Transfer Pricing Officer (TPO) and the Dispute Resolution Professional (DRP) after their 2011-2012 returns were selected for scrutiny by the revenue authorities. .The revenue authorities and the ITAT rejected this, ruling that the assessee ought to be taken as the tested entity. A Miscellaneous Application moved before the ITAT on this issue was also dismissed. .One reason for ruling against the assessee as far as their choice of associate enterprise as the tested party was concerned had to do with the fact that the assessee had not referred to as the associated enterprises as the tested party in their TP documentation. .However, since the TPO had also rightly gone beyond the TP documentation while searching for fresh comparables, the High Court said that the stance taken by the assessee in the TP documentation cannot be a ground to prevent it from contending that its foreign associate enterprise should be chosen as the tested party. ."... when the TPO himself has not attached any sanctity to the TP documentation as submitted by the assessee, (the ITAT) could not have foreclosed the assessee from canvassing the issue that the subsidiaries are least complex entities which should be taken note of", the Court said. .As far as the ITAT's finding that the the assessee had not shown the functional risks assumed by its associate enterprises, the High Court observed, "... it is not a case where there were no material produced by the assessee to establish the functional risk assumed by the foreign AEs. The material was available before the TPO but the TPO non-suited the assessee on the ground that such contention by referring to the foreign AEs as tested party was not part of TP documentation... the grounds canvassed in the miscellaneous application filed before the Tribunal on 28.09.2017, after the impugned order was passed by the Tribunal, would clearly show that all materials were available on file. Therefore, to non-suit the assessee stating that they miserably failed to establish functional risk is incorrect. If such is the conclusion which we have to arrive at, we have no hesitation to set aside the order of the Tribunal and we shall do so.".Ultimately, the High Court ruled:".... we are of the clear view that the findings rendered by the TPO, DRP and the Tribunal foreclosing the assessee's claim to refer to the foreign AEs as tested party is legally not sustainable.".It, therefore, has remanded this issue for fresh consideration by the Transfer Pricing Officer on merits, in accordance with law and while having due regard to the orders passed by the Transfer Pricing Officer in the assessee's case for subsequent assessment years. .Pertinently, the assessee had told the Court that the for the subsequent assessment years, i.e. AY 2012-13, AY 2013-14 and AY 2014-15, the TPO had accepted the assessee's approach on considering the foreign Associated Enterprises as tested party under similar facts and circumstance..The assessee had also raised grievance that several other susbstanial issues were not considered by the ITAT in passing the challenged ruling. The High Court found that there was nothing to show that the assessee had given up on these other contentions. Therefore, on these issues, the matter was remanded back to the Tribunal. .The tax appeal was allowed on these terms and the orders of the Tribunal, DRP and the TPO were set aside..Senior Advocate Kamal Sawhney along with Advocates Prashan Mehar Chandani, Amritha Sathyajith and Arun Karthick Mohan appeared for the appellant. Senior standing counsel, R Hemalatha appeared for the Income Tax authority. .[Read Judgment]